Five Reasons to Go Slow on C/QPP Expansion?

In December 2010, the federal and provincial finance ministers examined Canada’s retirement system and concluded it was reasonably sound.

At most, the system seemed to be in need of nothing more than minor tinkering. Thoughts of increasing the pensions paid under the Canada/Quebec Pension Plan (C/QPP) were shelved indefinitely and the focus shifted to developing a new, voluntary retirement savings vehicle: Pooled Registered Pension Plans (PRPPs).

Two years later, the federal government stunned many pension observers by announcing it will reconsider expanding the Canada/Quebec Pension Plan after all. Various options for expansion will be discussed by the finance ministers in June. So what happened?

In 2010, Alberta and Quebec were both opposed to expanding the C/QPP with only Ontario keen to proceed. The recent election of a pro-labour government in Quebec, however, eliminated Quebec’s opposition and was enough to tip the scales in favour of revisiting “Big C/QPP.” In the meantime, Ontario’s conspicuous lack of enthusiasm for PRPPs seems to have infected the other provinces, which are now dragging their heels after an early show of enthusiasm.

On the surface, Big C/QPP seems a no-brainer. A pension equal to 25% of the average wage – which is what the C/QPP currently provides – is obviously not enough for middle-income households, even if you add in OAS. Surely it would be a good thing for all working Canadians to have bigger pensions, especially given that the coverage ratio within private pension plan is down to only 21% (yes, 21%) in the private sector.

But when we take a closer look, the case for a bigger C/QPP is questionable at best, and if it is implemented poorly it can be a disaster. Here are five reasons why we should want to take it slow.

1. We don’t have a retirement crisis in spite of perceptions to the contrary, and none will develop for many years to come. The poverty rate among seniors is very low in absolute terms, less than half that of Canadians aged 18-64. An expanded C/QPP therefore starts to resemble a solution looking for a problem. The news is better than most of us realize. Nearly half of recent retirees have enough retirement income to replace more than 115% of their regular pre-retirement consumption.

2. The real looming problem in Canada is the rising cost of health care. We are already paying about $200-billion a year for health care and that is expected to rise by another 50% in real terms over the next 20 years. This is a serious problem because it will crowd out program spending for education and pensions. The rising healthcare bill will inevitably lead to higher taxes or user fees. Before we decide we’re ready to absorb higher C/QPP costs we should look more closely at where health costs are likely to end up.

3. We risk phasing in any improvements to the Canada/Quebec Pension Plan too quickly. This is what we did in 1966 when we provided a full C/QPP benefit after only 10 years of contributing a miniscule 3.6% of covered earnings and we are still paying the price today. The long-term cost of the Canada Pension Plan today is about 9.9% of covered earnings (it is about 11.2% in Quebec) though it should be closer to 6%. We are paying so much more because the previous generation didn’t pay enough into the C/QPP in its early years, leaving an unfunded liability that has to be amortized. If labour had its way, we would do the same thing again. The Canadian Labour Congress proposes a “small premium increase” to phase in a doubling of the CPP in just seven years. The fact is, the required contributions — employer and employee combined — would eventually have to climb to at least 16% of pay and possibly to over 20% if this doubling of the CPP is implemented retroactively. The quicker the phase-in the higher the ultimate cost. The situation is worse than it was in 1966-1976 because this time the 55-65 age group is so much larger. Quick phase-in means the next generation will be paying much more for their expanded C/QPP pension than it is worth. As if young people didn’t have enough reasons to resent the older generation!

4. An expanded CPP would enable us to continue to retire fairly early — the current average retirement age is 62 — and maybe even earlier. While this seems like a good thing, the worker to retiree ratio is dropping and will eventually fall from the present 4.4 to 1 to an estimated 2.3 to 1 by 2036. As this happens, we will need the 60-somethings to stay in the workforce longer to slow down this falling ratio. If we expand the C/QPP now so we can continue to retire early, employers and governments down the road will have find ways to reverse the effect in order to entice Canadians to do just the opposite. This is not exactly the most efficient strategy.

5. Fifth, expanding the C/QPP means we will be putting much more emphasis on just one pillar in our 3-pillar retirement system. One of the strengths of our current system (which ranks very highly internationally) is that Canadians get their retirement security from multiple sources. Indeed, we are praised by the OECD for the diversity of our sources of retirement income. An expanded C/QPP would induce us to contribute less to RRSPs and pension plans and increase our reliance on the government to provide for our retirement needs. This reliance is a little precarious. While we weathered the recent financial crisis much better than most countries, who is to say we won’t look more like Greece in 20 years?

If after all this, the consensus is that the C/QPP should be expanded, I would propose changes be phased in very gradually or better still, they should be implemented prospectively only (meaning no retroactive increases in benefits) so that we are paying for the increased pension we get rather than expecting our children to pay for it. Finally, we should use this opportunity to change the range of allowable retirement ages to anticipate when we expect we will be retiring in 20 to 30 years’ time. A quick survey of what is happening in social security systems around the globe suggests that a normal retirement age of 65 is becoming untenable.

Whenever I read op-ed articles by pension experts warning us to "go slow" on C/QPP expansion, I ask myself what's their angle and why are they failing to see that we've dragged our feet on C/QPP expansion for far too long?

The biggest myth of all is that we don't have a retirement crisis. When 20% of the population earns $15,000 a year or less -- basically poverty line -- and most people are struggling to make their rent, mortgage payments and cover their basic expenses, I find it hard to believe that "nearly half of recent retirees have enough retirement income to replace more than 115% of their regular pre-retirement consumption."

Second, no doubt Canada's health care costs are rising fast, especially in Ontario. There are many reasons for this, chief among them is an aging population and the fact that most people are severe hypochondriacs, overwhelming our health care system every time they get the sniffles (as the son of a physician and someone who grew up with doctors, I can tell you that there is a lot of waste in health care).

But rising healthcare costs are not as bad as doomsayers make them out to be (much worse in the US). And to say that our taxes will go up and therefore we should go slow on expanding CPP is disingenuous and fails to recognize that pension poverty also looms large and will potentially swamp our social welfare costs and add to rising healthcare costs.

Third, we have dragged our feet on C/QPP expansion for far too long. We can phase it in over years but the reality is the sooner we do it, the better off our citizens will be in their retirement. This is why I wasn't impressed with the grinches who stole CPP's Christmas.

Fourth, an expanded C/QPP will not enable us to retire earlier. This is rubbish. We should raise the retirement age to 67 in accordance with life expectancy. Of course, people need jobs to pay into pensions until they reach 67.

Fifth, and most importantly, expanding C/QPP means we will finally recognize the superiority of having our pensions managed by large, well governed public pension funds. People need to understand that over the long-term, their pension savings are better managed by professional pension fund managers who can invest across public and private markets, investing or co-investing with the best managers in the world. In short, RRSPs, PRPPs, and other defined-contribution solutions just don't cut it as they leave people vulnerable to the vagaries of the market. When it comes to improving our retirement system, we need to bolster our defined-benefit plans.

That pretty much sums up my thoughts on this flimsy article arguing to go slow on C/QPP expansion. Below, Bernard Dussalt, Canada's former Chief Actuary, shared his insights with me (in red):

Here is in a nutshell my analysis of Fred Vettese’s five stated reasons for
Canada to slow down on a CPP expansion;

1. We don’t have a retirement crisis in spite of perceptions to the contrary, and none will develop for many years to come. The poverty rate among seniors is very low in absolute terms, less than half that of Canadians aged 18-64. An expanded C/QPP therefore starts to resemble a solution looking for a problem. The news is better than most of us realize. Nearly half of recent retirees have enough retirement income to replace more than 115% of their regular pre-retirement consumption.

A crisis is an acute temporary condition. In that sense there is a dying retirement crisis that started with the large investment losses incurred by pension funds in 2008. As 35% of Canadian seniors do steadily rely on the GIS and have annual income in the range of $14,000 to $18,000, there is a chronic problem with the Canadian pension system that can be addressed only by compelling Canadian workers to save through the CPP. If close to 50% of recent retirees have more than enough retirement income, what about the other half?

2. The real looming problem in Canada is the rising cost of health care. We are already paying about $200-billion a year for health care and that is expected to rise by another 50% in real terms over the next 20 years. This is a serious problem because it will crowd out program spending for education and pensions. The rising healthcare bill will inevitably lead to higher taxes or user fees. Before we decide we’re ready to absorb higher C/QPP costs we should look more closely at where health costs are likely to end up.

A modest CPP expansion, e.g. increasing the pension rate from 25% to 35% would cost only about 2% of salary. With the resulting higher pension income, Canadian seniors would be in a position to assume themselves a portion of their health costs that the Canadian health care could eventually not be able to absorb.

3. We risk phasing in any improvements to the Canada/Quebec Pension Plan too quickly. This is what we did in 1966 when we provided a full C/QPP benefit after only 10 years of contributing a miniscule 3.6% of covered earnings and we are still paying the price today. The long-term cost of the Canada Pension Plan today is about 9.9% of covered earnings (it is about 11.2% in Quebec) though it should be closer to 6%. We are paying so much more because the previous generation didn’t pay enough into the C/QPP in its early years, leaving an unfunded liability that has to be amortized. If labour had its way, we would do the same thing again. The Canadian Labour Congress proposes a “small premium increase” to phase in a doubling of the CPP in just seven years. The fact is, the required contributions — employer and employee combined — would eventually have to climb to at least 16% of pay and possibly to over 20% if this doubling of the CPP is implemented retroactively. The quicker the phase-in the higher the ultimate cost. The situation is worse than it was in 1966-1976 because this time the 55-65 age group is so much larger. Quick phase-in means the next generation will be paying much more for their expanded C/QPP pension than it is worth. As if young people didn’t have enough reasons to resent the older generation!

By virtue of a recent amendment to the CPP, all eventual improvements to the CPP shall be fully funded. And they will. Full funding means no possible phasing-in whatsoever.

4. An expanded CPP would enable us to continue to retire fairly early — the current average retirement age is 62 — and maybe even earlier. While this seems like a good thing, the worker to retiree ratio is dropping and will eventually fall from the present 4.4 to 1 to an estimated 2.3 to 1 by 2036. As this happens, we will need the 60-somethings to stay in the workforce longer to slow down this falling ratio. If we expand the C/QPP now so we can continue to retire early, employers and governments down the road will have find ways to reverse the effect in order to entice Canadians to do just the opposite. This is not exactly the most efficient strategy.

The marginal pension provided by the CPP (about $12,000 a year currently) does not really help retire earlier. One of the main reasons workers retire early is most likely their reduced ability to work of their being forced out of the labour force by their employer. Besides, an early started CPP retirement pension is not synonym of retirement. Indeed, many CPP pensioners actually continue to work and to contribute to the CPP.

5. Fifth, expanding the C/QPP means we will be putting much more emphasis on just one pillar in our 3-pillar retirement system. One of the strengths of our current system (which ranks very highly internationally) is that Canadians get their retirement security from multiple sources. Indeed, we are praised by the OECD for the diversity of our sources of retirement income. An expanded C/QPP would induce us to contribute less to RRSPs and pension plans and increase our reliance on the government to provide for our retirement needs. This reliance is a little precarious. While we weathered the recent financial crisis much better than most countries, who is to say we won’t look more like Greece in 20 years?

The Greece problem is one of too high national debt. The CPP is a distinct standalone program not tied whatsoever to the national budget. Its benefits are paid only to the extent of its available fund. The multiplicity of retirement security sources is a no brainer. Netherlands, who is deemed by the OECD to have the best retirement system i the world, has no such multiplicity as most retirement income is generated by a single private mandatory occupational pension system. In any event, any reduction in the role of RRSPs in the Canadian pension system is not relevant because RRSPs do not essentially generate much retirement income, as a large proportion of RRSP accounts are withdrawn and used before retirement.

I thank Bernard Dussault for sharing this with my readers. Below, David McDonald, economist at the Canadian Centre for Policy Alternatives, on the growing income gap in Canada.

Bio, contact info and your support

I am an independent senior pension and investment analyst with years of experience working on the buy and sell-side. I have researched and invested in traditional and alternative asset classes at two of the largest public pension funds in Canada, the Caisse de dépôt et placement du Québec (Caisse) and the Public Sector Pension Investment Board (PSP Investments). I've also consulted the Treasury Board Secretariat of Canada on the governance of the Federal Public Service Pension Plan (2007) and been invited to speak at the Standing Committee on Finance (2009) and the Senate Standing Committee on Banking, Commerce and Trade (2010) to discuss Canada's pension system. You can follow my blog posts on your Bloomberg terminal and track me on Twitter (@PensionPulse) where I post many links to pension and investment articles as well as my market thoughts and other articles of interest. Please remember to support my efforts by clicking on the ads on the blog but more importantly by contributing via PayPal clicking on the buttons below. Anyone can contribute any amount at any time (all tips are greatly appreciated) but institutional investors are kindly requested to support this blog via an annual subscription of $500, $1000 or $5000 CAD (third option includes specialized consulting mandates). For all inquiries and comments, email me at LKolivakis@gmail.com.

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